What is the appropriate pricing regime for the Postal Service?

This is the fourth topic in our "Five Elements of a Postal Solution" blog series. Link to last week's topic.
Link to today's recap.
Link to Thursday's blog by John Waller.
Link to Wednesday's blog by Jeff Colvin.
Link to Tuesday's blog by Jessica Lowrance.

Recapping the week - March 30, 2012

In the fourth week of our blog series, we asked three experts to give us their opinions on an appropriate pricing regime for the Postal Service.

Our bloggers offered diverse ideas about a future pricing regime. Jessica Lowrance believes “eliminating the current concept of classes of mail is a natural step in streamlining operations and simplifying mail usage… [and]…it makes sense to adapt the product offering to how the USPS currently processes mail.” Jeff Colvin envisions “tailoring the price structure of bulk mail to the vast differences in delivery cost around the country.” Lastly, John Waller sees “current competitive market conditions warranting the exploration of a more flexible [price] cap with a narrower scope of application.”

Although Waller identifies the need for a more flexible price cap, he thinks the current requirement has had positive results because “it has forced cost cuts and attention on developing new business models.” However, Colvin points out that “the price cap freezes prices at inflation, effectively removing an important tool companies ordinarily employ to achieve financial stability.” Both do agree that a future price cap should factor in a continued decrease in mail volumes. Lowrance’s blog differs by focusing on Postal Service operations and mail classes. She states, “The major differences within operations are when and where the [mail] piece is accepted and the service standards surrounding the class of mail. The Postal Service could rationalize its services by creating shaped-based products that followed many of the same regulations that exist today.”

Comments to date on this week’s blog include varying ideas. Most agree there should be a responsible approach to increasing prices based on current market conditions. Others added that any Postal Service products or services that cost more than the revenue they bring in should be minimally priced at the breakeven level.

We thank each of the bloggers for their comments and will continue to keep the blogs open for additional input from the public. In addition, we invite you to keep up with the Office of Audit’s latest work through the Audit Project Pages. This site provides a forum for you to share your ideas, comments, and concerns on our open audit projects.

Next week’s blog series will examine the question: What should be done about the overfunding, overpayment, and other unfunded federal mandates?
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John Waller
The CPI cap requirement has forced cost cuts and attention on developing new business models. These achievements should not be lost in any new pricing requirements. But a CPI cap does not account for the impact of on-going volume and revenues erosion due to electronic diversion and economic downturns. Current competitive market conditions warrant the exploration of a more flexible cap with a narrower scope of application.

Without annual pricing flexibility in excess of the CPI, the Service becomes dependent on exigent, breakeven or legislatively authorized price increases, with periodic rate shock impacts as in the pre-PAEA days. With more flexibility in the cap and more limited application, these impacts can be avoided through manageable, predictable, annual increases sufficient to ensure a financially viable Postal Service.

Ideally, a new pricing policy would mimic PAEA requirements for competitive products as closely as possible. Market conditions will act as a restraint on unreasonable price increases given the competition that exists between postal products and the Internet, especially for commercial mailers. However, as a matter of public policy protection for the individual citizen mailer, a cap may still be warranted for single-piece letters and packages.

While the cap could initially be applicable only to single piece letters and packages, a safety valve could be established for other products by authorizing the Commission to extend the cap coverage, if unreasonable prices or undue discrimination is detected. The recognition that excessive price increases could trigger a death spiral will keep the Service focused on cutting costs and developing new sources of revenue. The Service has exercised appropriate restraint with reasonable, but above CPI, price increases for competitive products. This pricing flexibility has allowed those products to remain affordable and profitable yet keep management attention on cost cutting and innovation.

As with competitive products, it is reasonable to require market dominant prices to cover cost plus a reasonable contribution for institutional costs. If a product suddenly fails to cover costs, then a specific period of time could be required for returning the product to profitability before mandating price increases through the regulatory process. Pricing requirements should also foster workshare discounts to continue the privatization of upstream functions.

At some point it may be reasonable to transfer most bulk mail products to the competitive category. But in the meantime, once a lean system is established, removing the cap for commercial products is a means of testing the feasibility and value of such a move.

To the extent that a cap is retained, it should take into consideration the financial impact of the steady erosion in volume due to competing media. As volume declines, non-volume-variable costs in a lean postal system become a larger share of total costs and average unit costs increase even if input costs (labor, transportation, etc.) are under the CPI. The percentage of total costs that are fixed accelerates as volume becomes ever smaller due to the structure of street delivery.

The cap should also allow for price adjustments to offset the loss of contribution due to the change in mail mix. Since 2006, Standard mail has become the largest component of volume with about 1/3rd the unit contribution of the previously dominant First-Class.

Additionally, universal service requirements should be taken into consideration. The need for an above CPI cap can by mitigated by reducing legal constraints, such as a required 6-day delivery or mandated price preferences for certain products. If Postal Service requests for changes, especially in delivery innovations, are rejected, then the resultant impact on profit can either be subsidized or be incorporated in the cap to allow recovery of these costs through postage.

A future cap should be less than CPI if volume trends turn around. When volume is growing, price caps less than the CPI are reasonable. The Service could propose the mechanics of a new cap with adoption requiring regulatory approval based on public hearings. To allow a capability to respond to new price impacts, a legislated cap could be a simple CPI plus an x factor to be determined by an expert body informed by public hearings. The legislation could specify certain factors that must be considered in future caps, such as volume per delivery point.
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Guest Blogger Jeff Colvin, Director, U.S. Postal Service Office of Inspector General - March 28, 2012

Jeff Colvin

You hear it all the time.

Question: What company, facing a precipitous decline in demand for its product, would raise prices?

Answer: A state-owned monopoly, with a mandate to meet a multi-billion dollar service obligation.

Question: What company, losing billions a year, would not raise prices?

Answer: A business facing such powerful multi-modal competition that its captive market is slipping away like time into the future.

So the Postal Service, and the $900 billion industry it supports is in a huge mess – but what’s price got to do with it? And what can be done, via pricing, to make things better?

The problem is well-known. The Postal Service’s most profitable product First Class Mail was already battered by e-substitution, when the postal ship sailed into the greatest recession in recent memory. And it’s still taking on water, losing $1.3 billion in January 2012 alone, according to unaudited results filed with the PRC. January volume fell by 2.3% from last year.

While there is some improvement in shipping services, there isn’t enough to make up for the gigantic losses in the letter market. Like it or not, the action is all in letters, and increasingly, in bulk letters.

But raising the bulk letter price is not easy. The price cap freezes prices at inflation effectively removing an important tool companies ordinarily employ to achieve financial stability. Of course, Congress could soften its impact by loosening it to compensate for falling volumes, but it may not be enough. But Royal Mail and its regulator Ofcom recently concluded that even a cap watered down by such a volume-adjustment mechanism fails to provide for adequate pricing flexibility in labor intensive industries like postal.
More importantly, the pricing problem is not strictly a legislative issue. The Postal Service says that it wants to raise the stamp price to 50¢, but is much more cautious when it comes to raising bulk mail prices.

The worry is that demand might now be significantly more sensitive to price increases, because of e-substitution, than in the past. The jury is out on that one. The available research on what economists call ‘elasticity’ says First Class Mail, and even Standard Mail, are still pretty price insensitive, so much so that an increase in price would actually raise revenue and contribution. It may be that e-substitution to letters is more a trend, whose ebbs and flows depend more on technology and culture than on incumbent pricing.

Still, the question is an empirical one, and short of the basic research on whether demand characteristics have really changed, the obvious test – raise prices and see what happens – does carry risk. So, what can be done with prices to improve the Postal Service’s bottom line?

Let me offer a modest proposal. Why not tailor the price structure of bulk mail to the vast differences in delivery cost around the country. Delivery costs vary dramatically by ZIP code according to the density of the population. It would improve efficiency if prices tracked those differences.

In fact, simulations indicate that, even keeping total revenue constant, adjusting prices to delivery costs, could increase contribution by $800 million by shifting volume from high cost to low cost delivery areas.

It won’t solve the problem, but as they say, a billion here and billion there . . .

N.B: The views presented in this blog posting do not necessarily reflect the views of the OIG or any other organization. They are the views of the author alone.
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Jessica Lowrance
Today, the Postal Service offers an array of products that ultimately deliver a piece of mail from point A to point B. This original product has been sliced and diced to over 4,000 price points. From this price list, mailers pick the shape that best fits their mailing – a letter, flat, or package. Next, the mailers chooses a class of mail (First-Class, Standard, Periodicals, or Package Services/Parcels) based on rules and regulations established by the Postal Service. The Postal Service further distinguishes classes of mail by delivery or service standards. Additional services are available to mailers that occur pre- or post-delivery, especially if the piece is found to be undeliverable.

Eliminating the current concept of classes of mail is a natural step in streamlining operations and simplifying mail usage. From my perspective, it makes sense to adapt the product offering to how the USPS currently processes mail. Today, shape influences how a piece gets processed and which machines are used to move the mail through the system. This, then, affects how much it costs the USPS to process the piece and ultimately the price of the service.

In the eyes of a postal machine, a letter is a letter. The major differences within operations are when and where the piece is accepted and the service standards surrounding the class of mail. The Postal Service could rationalize its services by creating shaped-based products that followed many of the same regulations that exist today. Under such a revised product list, the Postal Service could offer a letter product that was differentiated further by where the piece was entered and the services purchased through the IMb.

For example, if the piece contained a bank statement and the mailer wanted 1-3 day service, it would be entered at a facility that met those service standards as well as any presort and destination entry requirements. The Intelligent Mail barcode on the piece could indicate that it was sealed against inspection and would be automatically forwarded if the recipient changed addresses. If the mailer wanted or needed additional return services, it could indicate which services were requested via the IMb. The Postal Service would no longer have to be concerned with processing preferred over deferred service letters, as all letter pieces when processed would be processed together.

This a la carte price offering would provide the mailing community with the opportunity to reach deeper presort levels and dropship further downstream in postal operations. Over time this should reduce upstream operations and postal costs.

In order to move forward with this suggested alternative, the Postal Service would need to go before the Postal Regulatory Commission to change its mail classification schedule (MCS). This process would allow for interested parties to comment to the Commission on the Postal Service’s new product categories and how it translates to existing service performance reporting, pricing, and costing.
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What is the appropriate pricing regime for the Postal Service?

The pricing of postal products is critical to ensure value for Postal Service customers. Although, the Postal Accountability and Enhancement Act of 2006 streamlined the pricing and classification process, no significant changes have been made in almost 6 years. Additionally, law requires that all market-dominant product price increases to be tied to a Consumer Price Index (CPI) price cap. Is this an adequate pricing approach for a 21st century postal service?

Are there other objectives that should be achieved with modern pricing? The Postal Service’s president and chief marketing/sales officer said ―”…when we make it simple to mail, our customers will do business with us.” However, mailers, employees, and the public do not always understand all of the prices the Postal Service offers. Stakeholders have noted that complex rates aren’t necessarily a bad thing for mailers and that most large mailers calculate their postage with a computer rather than paper and pencil. Is the use of computerized pricing by mailers a 21st century solution or a symptom of a disease?

In fiscal year (FY) 2010 the Postal Service had more than 7,600 domestic prices with 2,361 prices (31 percent) not used in FY 2010 and another 1,237 (17 percent) used on less than 10 mailpieces. This means that nearly half of the Postal Service’s domestic prices were not used by customers at all or not used often. Today there are over 8,000 domestic prices for the Postal Service’s three primary product lines: letters, flats, and parcels, along with additional services such as insurance, delivery confirmation, and certified mail. Does it make sense to have so many prices or should pricing be simplified?

Continuing pricing discussions include how to establish prices — a top-down or bottom-up pricing model? What pricing tools could potentially promote better efficiency and incentivize good performance? Are work sharing pass-throughs an efficient measure of costs avoided by the Postal Service? Is the CPI an adequate safeguard to ensure efficiency and financial viability for the future?

We would like to hear from you about how the Postal Service should or should not redefine pricing in support of a lean and simple national infrastructure with a right-sized workforce in the 21st Century and beyond.

For this week’s topic, we’ve also asked the following guest commentators to discuss this topic over the next three days:

• Jessica Lowrance, Executive Vice President for the Association for Postal Commerce, on Tuesday, March 27.

• John Waller, consultant on postal and regulatory issues, on Thursday, March 29.

We hope you can join the debate. Please check in throughout the week for their thoughts, and share your comments along the way. On Friday, March 30, we will summarize and conclude the discussion on this important topic.

Jessica Dauer Lowrance is the Executive Vice President for the Association for Postal Commerce (PostCom). She has been with PostCom for almost four years working with and representing business mailers to all postal stakeholders. Prior to joining PostCom, she was a pricing economist for the Postal Service.

Dr. Jeffrey Colvin has published many articles on postal issues. After 23 years with the Postal Service, he is now with the USPS Office of Inspector General.

John Waller is a consultant on postal and regulatory issues. Previously he was the Director of the PRC's Office of Accountability and Compliance.

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Comments (16)

teressa nickell

Practical ideas , I was fascinated by the information , Does someone know if my assistant could possibly access a template USPS PS 3602-EZ form to complete ?

Feb 09, 2017

selena swift

Helpful comments - I Appreciate the analysis ! Does someone know where my company would be able to locate a fillable USPS PS 3602-EZ form to fill in ?

Oct 24, 2016

selena swift

Fantastic comments - I am thankful for the points ! Does someone know if my company might be able to get a blank USPS PS 3602-EZ copy to edit ?

Oct 24, 2016

Tritglorlee

Intelligent Mail Barcode has also been referred to as OneCode, IMB and the 4-State Barcode. The Intelligent Mail barcode is a 65-bar code for use on mail in the United States and widely used for post filed. http://www.businessrefinery.com/products/barcode_net/barcodes/net-intelligent-mail-barcode-onecode.html

Jun 25, 2014

Amy

We must do something to save our postal service. Not every citizen -- particularly seniors -- as access or familiarity with the Web. If people want to write letters or mail biils, they should be allowed to, without being forced to use technology that might be complex to them. The USPS is an integral part of America and every effort should be made to save it!

Jan 04, 2013

ruth ann beaverson

I want to mail letters using a non profit permit. I fill out form #3602N and no where on the form is it listed the smallest number of pieces I can mail. One person at the post offices says I can mial 125, the next one says 200, and the next one says 250. Wtihout the number permited on the form how does one know the truth. Without this information, I should be able to mail any amount I want from 1 to what ever. What is the true number anfd why is it not printed on the form?

Apr 02, 2012

Talker

If you want to send Nonprofit Standard Mail, the minimum is 200 pieces or 50 pounds.
There are also special rates for putting pieces in carrier route order or mailing to most of the addresses on a carrier route. This may be where the 125 piece minimum you were quoted came from.
These links may be helpful:
Domestic Mail Manual
http://pe.usps.gov
Quick Service Guides
http://pe.usps.gov/text/qsg300/Q000.htm
Business Mail 101
http://pe.usps.gov/businessmail101/

Apr 02, 2012

James Kester

Why don't you simply use the "CPI"? It's all about energy right? Wages will likely be stagnant for the next decade.

Mar 30, 2012

IPP

John Waller makes some well-considered suggestions for postal pricing reform. Certainly they have the potential to improve matters. But I think it’s fair to ask, is continued bureaucratic pricing, with an emphasis on (adjusted) caps and hardcoded workshare cost linkages, really the answer? Perhaps it’s time to de-bureaucratize. But how does one do that when the postage-paying public needs protection from potential abuses of market power? The answer is to unbundle. Mail processing and transportation are not essential Postal Service functions. They can be performed by anyone, and in fact already are. If fully spun off to the private sector, their prices can be determined by market forces. Multiple firms are likely to contest those markets. A reasonable degree of competition can be also be assured by enforcement of the antitrust laws. In the long run, competitive markets for mail processing and transportation are virtually certain to be welfare-enhancing. The workshare paradigm which dominates current pricing practice can be relegated to the archives. (Has anyone ever heard of “worksharing” in any other industry?) For its entire history, worksharing was a second-best solution, anyway. It is based only on Postal Service “cost avoidances,” and therefore is strictly a supply-side construct. But any economist will tell you that both demand and supply must be considered for an efficient pricing solution. Worksharing was meant to mimic market forces. But why mimic when you can do the real thing? The only two essential Postal Service functions are retail and delivery. These are national treasures which should, after unbundling, be kept regulated as a public utility. The Postal Service will devolve to a first- and last-mile organization. The pricing question will become one of access. How much should be charged for first-mile access (acceptance)? How much should be charged for last-mile access (delivery)? These decisions will be regulated, but the focus should be on value to the public and on generating enough revenue to fund universal service. No longer will cost relationships within a vertical supply chain be the overriding determinant of prices at certain points downstream.

Mar 29, 2012

Just the Facts

Oh no! The death spiral!!! Cutting service and making chaotic changes to the retail and processing network undermine confidence in the viablity of the Postal Service. These changes are much more likely to cause harm as large mailers lose confidence in the Post Office.
I agree that products should cover their cost, but for most of the last 2 decades the Post Office and the PRC have been refusing to price Periodicals at cost. At some point, these institutions need to admit that they have failed in their responsibility to price Periodicals rationally. They have been out of complicance with the PRA and PAEA for so long it is almost a joke. Otherwise, neither the Post Office nor the PRC will have any credibility on pricing issues.

Mar 29, 2012

JohnK

I have to think &amp; agree with the post that any product/service that is currently running below actual costs needs to be immediately adjusted to a break even level. The USPS does not have enough volume nor profit in it's other services to continue to allow 'loss leader' products. While that may work in large retail environments, I believe in our industry that the same categories running below cost are NOT supplementing with additional volume product that the USPS can run at a profit to offset the loss. And regardless of category elasticity, why continue to run products at a loss? Adjust prices accordingly while also continuing to implement workplace and workforce efficiencies so that costs for services are inline with the requisite expense of providing that service.

Mar 28, 2012

Just the Facts

JSis, you have a good idea but the pricing is wrong. The Postal Service should make stamps for special occasions and charge more for them, not less. Sure they could still have the plain vanilla Forever Stamp, but they could also have stamps for Halloween, weddings, Valentines Day. St. Patrick's day that cost a few pennies more. You only use them if you like them. That's the basic idea behind Stamps.com products.
Everybody seems to think if the Post Office charges less it will all work out. It's not working out. It's just making some citizens subsidize the mail of other citizens. I don't hunt or fish, but my postage and taxes are helping to pay for the mailing of Field and Stream. I'm sure it's a great magazine, but its readers and publisher should be paying the freight, not me.

Mar 28, 2012

JSis

I have always thought that the post office should target certain markets like other companies. For example, my daughter is buying stamps for her wedding. Lots of stamps. How about a beautiful stamp for brides – at a slightly reduced rate – since they are buying so many? How about an art contest for the best wedding stamp!!. This is just one little example. We need good reasons for sending letters and for those reasons – market the heck out of it.

Mar 28, 2012

k

I agree. Discounts are given on large amounts of stamped envelopes, why not postage if they are all going to be used and not re-sold?

Mar 31, 2012

Just the Facts

I have to take issue with Jeff Colvin's remark that the demand for bulk mail may be more price elastic. The Postal Service's own demand studies clearly show that this is not the case. Since these are econometric studies, analyses can be done to test this hypothesis. The Postal Service has never published any such studies on bulk Market Dominant mail.
What elasticties does the Postal Servcie use at the PRC to support its annual price increases and its exigent price increases? The very same ones that they apparently disagree with. (Their 5-year plan cleverly says the elasticities are "in flux.")
Could it be that, not having stockholders to force its hand, the Postal Service lacks the polictal cover to raise its prices like UPS and FedEx do?

Mar 28, 2012

Name

Right on. What rational business wouldn't administer sensible and moderate price increases (that the market conditions can tolerate) when they are $11 billion in the red? And how about at least raising prices for those 13 underwater products at least to break even - or stop offering them and you will save on the losses incurred from offering them. Raising prices moderately and sensibly is what any rational economic agent would do. But this is not about sound economics; this is becoming about politics! My advice to the Postal Service: raise some prices as you continue to cut costs. Do both sensibly. That's the symmetrical thinking that is required for this crisis. Listen to the economists and pay attention to the market conditions - ignore the politicians and the lobbysists.

Mar 28, 2012

IPP

The greatest pricing imperative is that the Postal Service be able to come out from under the “market dominant products” price cap. The mechanism simply does not work for a network operation greatly defined by economies of delivery density and experiencing declining volume per delivery point. This can be proven mathematically. In general, prices need to go up. They are the lowest in the world, and cannot be sustained in the face of declining volume per delivery point. Additional reforms are likely necessary as well. For several decades, Postal Service pricing has been defined predominantly by structural discounts based on "workshare" cost avoidances. This is meant to promote economy-wide “productive efficiency.” While the workshare paradigm has some merit, it also has a number of drawbacks. For example, it imposes a top-down rigidity that can result in downstream prices out of line with local or niche market conditions—and ultimately "allocative" (as opposed to productive) inefficiency. Sooner or later, a reassessment of the workshare paradigm is likely to come. This will require a consideration of all social welfare implications, including the Postal Service’s ability to fund its universal service mandate. Related to this is the need for a comprehensive regime of access prices, especially as the Postal Service becomes more and more a “first- and last-mile” operation. A basic principle of public network economics is that “open and equal” access is provided to all parties, including affiliates. This will need to be considered. Finally, as Ms. Lowrance suggests, simplification of the price schedules is probably in order.

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